Review

Ben Hoffman describes the transition from a old world order to a debtor-aristocracy world order.

Consider a standard microeconomics model, where profits are good and debts represent some loss of that profit in interest; individual actions are taken based on whether they will be return more than they cost (and the return is above the best publicly available return). People lend gold to governments to get gold in return, and that gold is valuable across the world regardless of government policy.

Consider also a debt-based model, where there are more winner-takes-all dynamics. There might be some new (economic) land opened up, and a competition to see who gets it; if money can be turned into increased ability to win that competition, then more access to debt means more chance of win. (Think Uber vs. Lyft.) 

With the debt-based model, there's also more coalitional dynamics at play, as debt ties together borrower and lender; with the rest of their stake at risk, lenders are more likely to throw 'good money after bad', and with access to capital as a kingmaker, lenders may be more interested in propping up those that share their interests.

Of course, the main event is the transition from the gold-based economy with weaker states, to the cash-based economy with stronger states, and the main psychological event is the transition from an expectation of 'being in the clear' to an expectation of being heavily indebted. People used to talk about taking unsavory jobs to 'pay the mortgage', and now many talk about that to 'pay their student loan debt'.

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I think one of the important dynamics with debt is that it makes the race to the bottom worse because it lets people come up with clever ways of digging the bottom deeper. If there's some well calibrated amount of debt to take on some people will, by virtue of miscalibration, take on more than that, and others in a position to profit from that will have an incentive to create distortions to make such miscalibration more likely. Even worse than with individuals, this happens at the level of organizations including governments, whom many rely on as monopoly providers of many important goods.

The way to dig the bottom deeper today is to get government bailouts, like bailing out companies or lenders, and like Biden's recent tuition debt repayment bill.  Bailouts are especially perverse because they give people who get into debt a competitive advantage over people who don't, in an unpredictable manner that encourages people to see taking out a loan as a lottery ticket.

Consider my friend with the business plan to buy up laundromats. Let's say an illiquid, privately held laundromat makes a 25% return on invested capital. Suppose the stock market demands a 10% return for a small-cap company. So $100 million of privately held laundromats would generate $25 million in annual income, worth $250 million on the stock market, 2.5 times the initial investment. But if the laundromat company can finance 75% of the deal at 10% interest, then the cash cost of acquisition is $25 million. The cash flow profits of $25 million are reduced by $7.5 million in interest payments, for a net annual profit of $17.5 million. This company could sell for $175 million on the stock market, seven times the initial cash outlay. For this reason, orthodox financial theory recommends that companies borrow as much as they can get away with and roll over the debt perpetually, to maximize return on equity.

In the long run this subsidy to large purchasers should inflate the market price of inputs for the laundromat industry, simultaneously increasing the market price and reducing the profitability of existing businesses, creating increasing pressure to sell out.

I think even without the "subsidy to large purchasers", the situation described would have a much simpler outcome: everyone and their mom would start laundromats and drive profitability well below 25%. And the market price of existing laundromats might well fall as a result, not increase as the post says.

How many people do you think have both of these traits?

1 Access to enough capital to execute on that plan and expect it to be positive-EV taking into account not only opportunity cost, but risk.

2 Regularly calculates the ROI on different business categories they interact with, to look for business opportunities.

Seems to me like this number is very small, most people doing this are pretty busy making loads of money, and then their kids don't execute the same strategy so it doesn't snowball intergenerationally. And the rest of the post explains why, structurally, we should expect this class to have shrunk quite a bit in relative terms over the last several decades.

I agree that under naive microeconomic assumptions what you predict would happen, and I wouldn't be seeing what I'm seeing.

I don't agree that the debt/capital distinction has changed all that much.  Personal debt (for a mortgage on a house you're occupying, or for student loans, or for other non-income-stream purposes) isn't much of a driver of economies or decisions at scale.  Corporate debt, as compared with share ownership, is still an important claim on future income/assets.  

I guess I'm saying the standard microenomic model dominates - profits are good, and debt represents reduction of future profits.  Investments (non-consumption lending or spending-with-expectation-of-future-returns) pretty much behave as you say.  Consumption spending never has.

It's not clear why you'd expect debt ties borrower and lender together more than share-based investment does.  Usually the opposite is claimed, and that matches my intuition as well.  

Or maybe I'm missing the "compared to what" in this claim.  Debt and shares are both "access to capital", and they have different result curves which lead to preferring one or the other for different risk profiles (and tax policy messes with this a lot).  But they're roughly the same in terms of how effectively the money can be deployed as capital.

edit: retracting this - I read the link and realized that the post's summary had very little context that tied it to the social justice roots of the concept.  I don't have a lot to say about the distribution of wealth, disconnected from use of capital to actually make stuff.  

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